Stay on Board

BIG PICTURE - Over the past few weeks, geo-political tensions have
increased in various parts of the world and we have also experienced a sovereign
debt default. Despite these developments, the majority of the stock markets
have held up relatively well and so far, we have not witnessed any panic-fueled
liquidation of assets.

Although this can change, we are inclined to believe that these 'events' will
not derail the primary uptrend in equities; and if anything, changes in the
monetary landscape will bring about the next prolonged bear market.

Remember, when it comes to investing, monetary policy trumps everything else
and the business (credit) cycle is dictated by changes in the cost of borrowing.
When interest rates are low and credit is cheap, business activity picks up;
and when borrowing costs rise, credit becomes tighter and economic activity
slows down. Furthermore, the stock market is primarily driven by corporate
earnings, so a slowdown or contraction in business activity brings about a
bear market.

If you review Figure 1, you will observe that over the past 60 years, economic
recessions in the US (shaded areas on the chart) have always occurred after
a significant increase in the Fed Funds Rate. Put another way, not a single
economic recession has come about without a prior rise in the Fed Funds Rate.
This correlation clearly demonstrates that the economy (business activity)
is directly controlled by the cost of borrowing.

As far as the stock market is concerned, it is worth noting that the previous
prolonged bear markets (1974-1975, 2000-2003 and 2007-2009) coincided with
economic recessions; which were brought about by the inversion of the yield
curve.

Looking at the current situation, the Fed Funds Rate is still at a historic
low and it is probable that Ms. Yellen will raise it sometime next year. Thereafter,
if inflation expectations remain contained (probable outcome), it is likely
that the Federal Reserve will raise the Fed Funds Rate in baby steps.

Although we do not possess a crystal ball, we suspect that the monetary tightening
will go on until 2017-2018 and during this cycle, the Fed Funds Rate will peak
around the 3-3.5% level.

Under the above scenario, the ongoing primary uptrend in stocks will probably
continue for another 3-4 years, so we suggest that investors stay on board
this powerful bull.

Look. The ongoing primary uptrend is now 5 years old, so there can be no doubt
that we are now in a mature bull market. Nonetheless, given the favourable
monetary policy and the timing of the US Presidential Cycle, it is probable
that the next couple of years will be very good for Wall Street.

If you review Figure 2, you will note that since 1928, Years 3 & 4 of
the US Presidential Cycle have been very bullish for US stocks. At the time
of writing, we have arrived within three months of the third year of the US
Presidential Cycle; a period which has proven to be extremely beneficial for
American stocks. Thus, we believe that investors should get ready for an exhilarating
ride!

Figure 2: US Presidential Cycle and the stock market

Source: BofA Merrill Lynch Global Research

Even though the broad stock market is likely to perform well over the following
months, we do not believe that every industry group will participate in the
festivities. Accordingly, investors will need to concentrate in the strong
sectors and invest capital in the leading stocks. Conversely, in order to preserve
capital, the weak industry groups will have to be avoided at all costs.

Narrowing in on the various industry groups, it is notable that asset management,
automobiles, banks, biotechnology, healthcare, insurance, semiconductors, transportation
and travel related stocks are performing well. Conversely, consumer discretionary,
consumer staples, richly valued growth stocks and small-cap issues are currently
out of favour with investors and unless the price action improves, these should
be avoided.

Meanwhile, after a strong rally, it appears as though the energy counters
are now undergoing a pullback (Figure 3) and this period of weakness may continue
for several weeks.

For our part, we have recently made a few changes to our equity strategy and
our portfolio is now well positioned in the strong sectors of the stock market.

In terms of geographical exposure, it is worth noting that the stock markets
of the developed world are performing well and even Japan's NIKKEI seems to
have completed its lengthy consolidation phase. Given the fact that the Japanese
Yen has started weakening again, it is probable that over the following months,
the NIKKEI will surpass its last year's high.

Apart from the developed world, it is interesting to see that the stock markets
of the emerging nations are also showing signs of strength and over the past
few weeks, many prominent indices have broken out of lengthy trading ranges.

You will recall that in spring, we had highlighted India as an interesting
investment opportunity. Today, in addition to India, we also see strength in
Brazil, China, Hong Kong, Philippines, Singapore, South Korea, Thailand and
Taiwan.

For our part, we have recently allocated some capital to the emerging world
and it is our belief that this investment will produce satisfactory growth
over the next couple of years. Make no mistake, from a valuation perspective,
the emerging markets are inexpensive; so a 'catch up' rally could be on the
cards. Furthermore, in the recent past, China has reported better than expected
economic data and this is good news for the world's second largest economy
as well as its major trading partners.

In summary, bearing in mind the accommodative monetary policy and the US Presidential
Cycle, we are of the view that Wall Street will continue to advance for another
2-3 years. Undoubtedly, this will have a positive impact on the rest of the
world, so investors should stay aligned with the primary trend. In terms of
geographical allocation, we recommend that our readers stay overweight the
developed world whilst maintaining a modest exposure to the emerging nations.
Finally, as far as sectors are concerned, we advocate exposure to the cyclical
counters which tend to perform well during a late-stage economic recovery.

COMMODITIES - Let's face it; commodities topped out in April 2011 and
they are now in the grip of a secular downtrend.

During the past decade, the US Dollar was in a relentless downtrend and the
Chinese economy was powering ahead. These two factors unleashed an epic bull
market in commodities; an advance which continued for 10 years!

Today, the US Dollar is strengthening and the Chinese economy is slowing down.
Thus, these two factors are now acting as a headwind for the prices of commodities.
If our assessment is correct, the greenback will appreciate over the following
months, thereby putting additional downward pressure on commodities.

If you review Figure 4, you will note that after advancing sharply at the
beginning of the year, the Reuters-CRB (CCI) Index abruptly reversed course
in April and it has now sliced through the key moving averages. Therefore,
the path of least resistance is now down and additional strength in the US
Dollar could bring last year's lows into play.

Turning to specific commodities, it is noteworthy that despite the ongoing
geo-political tensions in the Middle-East, the price of crude has fallen to
a multi-month low and by doing so, it has sliced through the key moving averages.
Therefore, the trend in oil is down for now and any rally attempt may fail
around the US$100 per barrel level.

Elsewhere, the price of copper is still holding above the key moving averages
and this is on the back of China's better than expected manufacturing data.
Despite copper's resilience, we continue to believe that the metal is oscillating
within a trading range and a strong rally is unlikely.

Finally, over in the agricultural complex, although coffee is experiencing
a counter-trend rally, the prices of corn and wheat have declined to a 4-year
low. Furthermore, the price of sugar has also fallen beneath the key moving
averages and the path of least resistance remains down.

Given the bearish price action in commodities, the related stocks are also
feeling the pressure, and it appears as though a pullback in these securities
is now underway. Therefore, nimble traders can consider locking in their recent
gains.

Puru Saxena is the CEO of Puru Saxena Wealth Management, his Hong Kong based
SFC regulated firm which offers discretionary portfolio management and research
services to individual and corporate clients. The firm manages two trend-following
strategies - Discretionary Equity Portfolio and Discretionary Fund
portfolio. In addition, the firm also manages a Discretionary Blue-chip
Portfolio which invests in high-dividend world leading companies. Performance
data of these strategies is available from www.purusaxena.com

Puru Saxena also publishes Money Matters, a monthly economic report,
which identifies trends and highlights investment opportunities in all major
markets. In addition to the monthly report, subscribers of Money Matters also
receive "Weekly Updates" covering the recent market action. Money Matters is
available by subscription from www.purusaxena.com